Does a refinance appraisal affect property taxes?

In recent years, refinancing real estate has become an emerging strategy among real estate investors to build their real estate portfolios. Popularized by the Buy, Renovate, Rent, Refinance, and Repeat method (BRRRR), many real estate investors now purchase properties with the goal to remodel them, rent them out to generate cash flow, and then refinance the property to capture the equity they’ve created and use the cash to buy a new property and do it all over again.

In this process, refinancing plays the most critical role, and when it comes to refinancing any property, lenders will usually require another appraisal. Many investors, however, erroneously assume that this second appraisal will cause their property taxes to increase. In this article we dive into detail why this is not necessarily the case.

What is an Appraisal

A real estate appraisal is the professional determination of the value of a property based on the evaluation of an independent, unbiased party, referred to as an appraiser.  While an individual seeking to borrow the money is ultimately the person that pays for an appraisal, it is the mortgage lender, that benefits most from having an appraiser valuate the property.

This is because prior to disbursing cash out to assist someone in the sale, purchase or refinance of any form of real estate, lenders want ensure that the property is actually worth the value that has been assigned to it in the contract. As a sound business practice, lenders don’t want borrowers to overpay for properties, and they certainly don’t want to lend out more money than what a property is worth.

This is because in a worst-case scenario where the borrower does default, it is the lender who will be forced to foreclose and gain ownership of the property from the borrower. At that point their only way to get their money back is to re-sell the property on the open market, and if the property was overpriced in the first place this could result in a huge loss for them.

How a Property is Appraised

In order to determine the value of a property an appraiser will first inspect it in person. They will take pictures of both the property’s interior and exterior, making notes on the condition, how well it has been maintained, the level of finishes, the floor plan layout, the overall square footage, and the amenities that add to the value of the property.

They will then research and analyze trends in the local real estate market, interview local real estate agents, and evaluate other homes in the area. The goal being to find three properties that sold within the past six to twelve months that are most similar to the one that is being appraised, and use these as benchmark to reverse engineer what the value of the subject property should be.

Comparing the properties line item by line item, the appraiser will add and subtract value to the subject property depending on how well it stacks up to these other properties. For example, if the subject has a pool and the other similar sized comparable homes do not, then that could be a $50,000 valuation given to the property above what the other homes sold for.

Likewise, if every other comparable property has a pool, but the subject property does not, then it would be a $50,000 subtraction of the value of the subject property compared to the value of the others.

The appraiser’s final determination of a property’s value is summarized into an appraisal report that is then provided to both the lender and the borrower.

The Three Types of Refinance Loans

Refinancing refers to the process where a property owner replaces their existing mortgage with a new one, in order to either save money or capture the equity in their home. Understanding when a refinance appraisal is required and how these could potentially affect property taxes, begins with understanding the three main types of refinancing loans first.

Rate-and-term Refinance Loan

The first is a rate-and-term refinance, when the property owner simply replaces their existing mortgage with a new one that has either a more favorable interest rate, loan term, or both. Property owners opt for this type of refinancing when they want to save money on interest over time and lower their monthly mortgage payment.

Because the U.S. is currently experiencing one of the lowest interest rate environments in years, many real estate investors who are adopting a buy and hold strategy pursue rate-and-term refinance loans in order to lower their monthly operating expenses, and therefore increase the net monthly income generated from the property.

Typically obtaining a rate-and-term refinance loan for will require an appraisal, unless the underlying loan is an FHA, VA, USDA, or Jumbo loans. Through a program called Streamline Refinances, refinancing these types of loans generally doesn’t trigger the usual credit history, asset, and appraisal requirements because the loan balance remains the same, and the lender can use the existing information on file.

Mortgages that fall outside of these categories, referred to as non-qualified mortgages, our specialty here at Aurum and Sharpe  can require a refinance appraisal, depending on the lender’s own policy. However, again, because the loan balance remains the same and only the interest rate changes, some lenders may choose to waive this requirement, especially if not that much time has passed since the last appraisal took place.  

Cash-Out Refinance

A cash-out refinance is when a homeowner believes their property has substantially increased in value and they would like to get a new, larger loan, to both replace the existing one and pocket the difference as cash.

This is a very common refinance loan among real estate investors, especially those using the BRRRR method. They will purchase a property for $300,000 and get a mortgage for $240,000. Through repairs and renovations, the value of the property increases to $600,000, and they decide to do a cash out refinance. They get a new loan for $480,000 that pays off the previous loan of $240,000, leaving them with $240,000 which they will receive as a check at closing. This $240,000 they are then free to use however they wish, including by purchasing another property and repeating the process again.

It is important to note that typically with a cash-out refinance loan, property owners must leave 20% equity in the home. 

Resultingly, the ability to secure a cash-out refinance loan like this is directly dependent on the lender being able to determine the value of your home, which is why most banks and lenders will require a refinance appraisal.

Home Equity Line of Credit

A home equity line of credit, or HELOC, is similar to a cash-out refinance. Property owners can convert their home’s equity into cash, that can be used freely to acquire more properties. The key difference, though, is instead of receiving a lump sum payment as you do with a cash-out refinance, when a property owner gets a HELOC they don’t necessary receive the cash right away.

The loan amount that they are approved for acts as a line of credit, very much like a credit card, that they can draw from anytime they like. Only when cash is used will interest begin to accrue.

HELOC’s typically allow borrowers to leave only 15% equity in their home, which makes them another favorite for real estate investors. Using the example from above, if that same real estate investor decides to get a HELOC on a $600,000 property, they may qualify for a new loan amount of $510,000, $30,000 more than what they’d receive under a cash-out refinance loan.  After using the funds to pay off the underlying $240,000 mortgage, they would now have $270,000 at their disposal.

Because a home equity line of credit is also directly determined by the value of the property that acts as collateral for the loan, a refinance appraisal is also generally required.

How Property Taxes Work

Before jumping into how the refinance appraisal affects property taxes, we’ll now take a look at what property taxes are and how they work.

Property taxes are annual assessments placed on all real estate by local governing bodies to fund public services, such as schools, road maintenance, infrastructure, emergency services, and more. Property taxes are an annual assessment, payable in two parts, every year. Amounts of which are largely determined by a local tax assessor, at either the city or county level where the property is located.

In order the calculate the property taxes due, the tax assessor begins by reviewing the total municipal budget for the applicable taxing jurisdiction. He or she subtracts out revenue collected through sales tax, state aid and other sources other than property taxes, and then based on the remaining amount, or tax levy, sets a uniform tax rate that is subsequently applied to every property.

The tax rate is typically an amount set per $1,000 of the assessed value of the property. For example, a tax rate of $5.00 per $1,000, levied on a $500,000 home would mean the homeowner has a $2,500 property tax bill.

Because the tax rate is largely driven by the local budget voted upon by taxpayers in the area, it is subject to change each year. The other component of property taxes that is subject to change is the actual assessed value of the property being taxed.

How a Property is Assessed for Taxes

In the case of the tax assessor, a change in a property’s assessed value is usually triggered by two key events.

Sale of a Property

Anytime a property changes ownership, tax assessors will assess the property a new value that is the equal to the sales price. The reasoning being that the market value will provide the most accurate estimate of the value of the property. This new assessed value set when the property is transferred becomes the base year value, and then in the years to follow the assessed value of a property can only increase by a small, set amount, usually 1-2 percent annually depending on the state. It is only when the property is resold or another transfer of ownership occurs, that the assessed value is reset to the sales price, and this becomes the new base year value.

For example, if a property was sold in 2017 for $200,000, that is the sales price the local tax assessor would use to calculate the property taxes owed. In the years between 2018 and 2020, the assessed value would be $200,000 increased by 1-2% each year. And if the property were resold again in 2021 for $400,000, the $400,000 would reset the base year value from $200,000 to $400,000.

New Construction & Additions

The assessed value of a property is also subject to change whenever major construction takes place on a property. The tax assessor receives copies of permits from local building department for any major additions and construction made to a property. They then use this information to assess what the value of these improvements are, largely based on the value that the building department assigned the project when calculating the permit and development fees.

The value of these additions and upgrades are considered market value in the year that the construction work is completed, and this value is then added to the existing assessment. In the year of construction completion, the portion of your property’s value that is assessed to the structures that were already existing, will remain the same, and a new value, assigned to the improvement will be added.

As an example, if a real estate investor decides to add a second unit to a $500,000 home that is given a $100,000 valuation by the local building department, the tax assessor will do a split assessment. The existing home’s assessed value will remain the same, and the new unit will receive its first base year value of $100,000. Only in the following year will the property’s total new assessed value combine to become $600,000.

Fortunately, structural repairs, general maintenance and interior remodeling of a property that doesn’t require permit work is not considered new construction and won’t trigger a re-assessment of a property for tax purposes.

Which Appraisals Affect Your Property Taxes

Real estate investors and property owners considering a refinance can therefore breathe a sigh of relief when getting a refinance appraisal.

The appraisal that you receive when you refinance the property is a private document shared only between the appraiser, the lender and the borrower. At no point is it given to the tax assessor. Additionally, because a refinance does not involve a change in the ownership of the property, tax assessors have no reason to re-assess your property just for getting a refinance and receiving a refinance appraisal.

It’s if, and only if, you’ve made improvements to a property that qualify as major construction work prior to getting a refinance loan that you could possibly experience an increase in property taxes. Again, though, this increase in property taxes would only be triggered by the work itself, and not the refinance appraisal. Therefore, for real estate investors who seek to refinance a property after performing average remodeling and repairs, such as new flooring, paint and landscaping, it is highly unlikely they will experience any increase in property taxes, which means they will be able to maximize the cash flow from the property.

It is only the appraisal that you receive when purchasing a property, can have an indirect effect on your taxes. While, of course, this appraisal is a private document that is not shared with any public governing body, the value assigned to your property by an appraiser plays a key role in the amount the lender will let you borrow as well as the ultimate purchase price of the property. Because the sales price of a property is what local taxing bodies do see, and will use to calculate your property taxes, in this way a sales appraisal will affect your property taxes.

Maintaining Your Bottom Line

Now that you can breathe a sigh of relief knowing that your property can not be re-assessed simply when you get a refinance appraisal, it’s important to know why this is a benefit to you. 

Ultimately the goal of every real estate investor is to save as much money as possible, and to generate as much net income as possible from every property they own, especially if it’s a rental. When it comes to owning real estate the two biggest cost drivers are the underlying interest rate and the property taxes. Followed by a myriad of other expenses such as vacancy, utilities, and general maintenance, especially in cold weather climates. The less operating expenses that you have the better you are financially, and the more successful you can be in the long run.

Therefore, by now understanding why a refinance appraisal will not erode an your bottom line, and in fact help you achieve your goals an investor, you can now approach building your real estate portfolio with confidence.

As an expert in all non-qualified mortgages, from interest only loans for investors, bank statement loans, no asset loans and more, give me a call at Mortgage Rates